The most common types of taxes

And how they may affect your finances

Taxes affect just about every aspect of our lives. They apply to our paychecks, the prices of products we buy, and the services we use. You may also have to pay taxes on your home, your car, investments, and money you want to pass on to your loved ones as you get older. Sometimes the lines blur between the different kinds of taxes, but below we’ll cover three common methods of taxation — progressive, regressive, and proportional — as well as the most common types of taxes you may encounter.

Key takeaways

  • Taxes are generally progressive, with higher rates the more you have; regressive, with lower rates as you have more; or proportional, with you always paying a flat rate

  • There are many types of income taxes for everything from your salary to an inheritance

  • Sales tax is a type of ad valorem tax that applies according to the value of the good or service you’re buying

  • Excise taxes are are a popular way governments to raise revenue and include classic sin taxes, such as on alcohol and tobacco

Three main types of taxes

While there are individual taxes, there are three main types of taxation and they describe ways that a tax applies to the person or group being taxed:

  • Progressive taxes

  • Regressive taxes

  • Flat or proportional taxes

Progressive taxes

With a progressive tax, the more income you have that is subject to tax, the higher your average tax rate is. The term “progressive” comes from the fact that as taxable income increases, the tax rate gets progressively higher. Most income taxes in the United States are progressive taxes. A progressive income tax may also be referred to as a graduated income tax.

Regressive taxes

The opposite of a progressive tax is a regressive tax. With regressive taxes, as you have more that is subject to tax, your average tax rate is lower. One example of a regressive tax is the Social Security tax, a type of payroll tax that everyone needs to pay on their first $142,800 of income in 2021. [78] The higher your income goes above that limit, the lower the average rate that you pay on your overall income.

Proportional and flat taxes

A proportional tax, or flat tax, is one where the amount you pay is proportional to the amount of income you have. For example, if a state had a flat income tax of 5%, each taxpayer would pay 5% of their taxable income, regardless of how much income they have.

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Taxes on income and wealth

Most forms of income and wealth are subject to tax in the United States. The following are examples of the types taxes you may actually pay in your daily life:

  • Federal income tax

  • Alternative minimum tax (AMT)

  • State and local income taxes

  • FICA and other payroll taxes

  • Self-employment tax

  • Capital gains tax

  • Estate tax

  • Inheritance tax

  • Gift tax

  • Generation-skipping transfer tax

  • Wealth tax

  • Business and corporate taxes

Federal income tax

The federal income tax applies to your wages, earnings, and other forms of income. U.S. income tax is a progressive tax with marginal tax brackets, where each tax rate applies only to income within a certain range. Income tax is collected over the course of the year, usually by withholding a certain amount from each of your paychecks. If you are self-employed or a freelancer, you will probably need to make estimated tax payments each quarter since no tax is withheld from your paychecks. Ideally, you would pay the exact amount of tax you need to, but most people overpay and receive a tax refund each year after filing their income tax return.

Learn more about how to file your income taxes.

Alternative minimum tax (AMT)

The alternative minimum tax is another type of federal income tax that works alongside the regular system. If you have certain kinds of income or wealth — like some employee stock options — they aren’t always subject to regular income tax. AMT covers these other sources of income to ensure that you pay tax on them if they are worth more than a certain amount. AMT doesn’t start to apply until your 2021 income reaches $73,600 if you’re a single filer or $114,600 if you’re married filing jointly. [79]

Related: How to determine your tax filing status

State and local income taxes

Like the federal government, most states have their own income tax for residents of the state and potentially people who work in the state even if they don’t live there. Most states also all have a progressive tax with marginal tax brackets, though the number of brackets and the income ranges differ. For example, Alabama has tax rates of 2%, 4%, and 5% depending on your income.

Only seven states do not have an income tax:

  • Alaska

  • Florida

  • Nevada

  • South Dakota

  • Texas

  • Washington

  • Wyoming

New Hampshire and Tennessee do not tax most regular income but do tax income from interest and dividends. (Tennessee’s tax on investment income will expire in 2022.)

Nine states have a flat income tax:

  • Colorado

  • Illinois

  • Indiana

  • Kentucky

  • Massachusetts

  • Michigan

  • North Carolina

  • Pennsylvania

  • Utah

Some cities, counties, and local governments also collect income taxes. As examples, in Missouri, both Kansas City and St. Louis collect an income tax. In Maryland, each county collects its own income tax. In Oregon, cities in the Portland area pay an income tax to support public transit.

FICA and other payroll taxes

Employers remove payroll taxes from each of your paychecks and send them to the appropriate government agency. In addition to income taxes, there are federal taxes that fund Social Security and Medicare , which together are the FICA (Federal Insurance Contributions Act) taxes. The Social Security tax is 6.2% of an employee’s income and the Medicare tax is 1.45%. Employers also contribute an equal amount of FICA tax for each employee.

There is an additional Medicare surtax of 0.9% for single filers who earn more than $200,000 and joint filers who earn more than $250,000. This tax applies only to income above those thresholds and is called the Additional Medicare Tax.

Self-employment tax

If you’re self-employed, you still have to pay income and payroll taxes. But instead of paying income tax out of your paychecks the way employees do, you will need to make quarterly estimated tax payments to the IRS.

To pay into Social Security and Medicare, you will need to pay self-employment tax, which you may also see called SECA tax (Self Employed Contributions Act Tax), instead of FICA tax. SECA is the same as FICA except that you pay twice as much as a regular employee to cover what’s usually the employee and employer portion of the taxes. The good news is that you can deduct 50% of your self-employment taxes when you file your annual income taxes.

See more tax deductions and credits you can claim in 2021.

Capital gains tax

When you sell assets — like investments, real estate, or a cryptocurrency — you likely have to pay capital gains tax on your net gains. You may also have to pay tax when you sell collectible or valuable items, such as jewelry or a collection of rare stamps.

The capital gains tax rate you pay depends largely on how long you owned the asset. You pay the short-term capital gains rates if you held assets for one year or less. These rates are the same as regular income tax rates. You pay the long-term capital gains rates, which are lower than the regular tax rates, if you held assets for more than one year. Note that states that collect income tax also collect capital gains taxes.

Learn more in our guide to capital gains tax.

Estate tax

Estate tax applies to the money and assets in your estate — the collection of everything that’s passed on after your death, like cash, investments, real estate, and other valuables. You may see estate tax called a death tax.

The federal government collects an estate tax, but very few estates have to worry about it because it only applies to estates worth at least $11.7 million in 2021. The District of Columbia and 12 states also have their own estate tax, with some states using the same exemption as the federal government — estates worth less than $11.7 million being exempt in 2021 — but some states have lower exemptions. Massachusetts has one of the lowest exemptions at $1 million.

(Most of your assets factor into your estate’s value, but note that the death benefit from a life insurance policy does not.)

Inheritance tax

Similar to an estate tax, inheritance tax applies to what’s passed on after someone dies. However, the person inheriting the money or assets must pay the inheritance tax. There is no federal inheritance tax and just six states collect an inheritance tax. (Maryland is the only state to collect both an estate and inheritance tax.) Inheritance tax rates depend on how much you inherit and your relationship to the deceased. Spouses are always exempt from inheritance tax.

Do you live in a state with inheritance tax? Understand what you may have to pay with our state-by-state guide to inheritance taxes.

Gift tax

The federal gift tax applies when someone gives money or other valuable assets worth $15,000 or more to someone else. The person giving the gift is the one who has to pay gift tax, though no one actually has to pay it unless they’ve already given away enough during their lifetime to exceed the lifetime exclusion of $11.7 million in 2021. So while a gift of $50,000 would exceed the annual exclusion and you would need to report that gift to the IRS, you may not actually have to pay tax on it. Gift tax can also apply if you sell something for less than its fair market value, like if you sell someone a car that’s worth $30,000 but only receive $10,000 for it. Gift tax works in conjunction with estate tax 

Read more about what gift tax is and who pays it.

Generation-skipping transfer tax

Alongside the gift tax there is also the generation-skipping transfer tax (GST tax). The GST tax applies any time someone gives money or valuable assets to a grandchild or to an unrelated person who is at least 37.5 years younger than they are. The generation-skipping tax exemption is the same as the annual and lifetime gift tax exclusions.

To minimize GST taxes, consider a generation-skipping trust.

Wealth tax

A wealth tax is a tax on a person’s entire net worth. Your net worth is the combined value of your annual income, personal savings, investment accounts, property, real estate, and other belongings, like jewelry or collectibles.

The U.S. does not have a wealth tax, though some politicians have proposed one as a way to raise tax revenue. The most similar type of tax is the federal estate tax, but that only applies to an estate’s value after an individual passes away.

See how your net worth compares to the average American.

Business tax and corporate income tax

With individual income taxes, you generally pay tax based on the total amount you made (revenue). Corporate taxes typically apply to a company’s profit, which is its revenue minus expenses. Corporate tax rates are also different from individual tax rates. Instead of the seven marginal rates, the federal corporate tax rate is a flat 21%. Many states also have rates that are different from their regular income tax rates. For example, Maine’s personal income tax rates start at 5.8% and go up to 7.15% across three income brackets. The corporate tax rates range from 3.5% up to 8.93% across four brackets.

Taxes on property

Property taxes are considered ad valorem taxes. An ad valorem tax is based directly on the value of a good, service, or real estate property. The most common type of ad valorem tax in the U.S. is property tax for your home and other real estate. States may also have personal property taxes that apply to valuable possessions like a car or boat.

Ad valorem taxes generally involve determining the fair market value (FMV) of your property and then applying a tax rate to either it’s full FMV or a pre-determined taxable portion of the FMV.

Property tax

When you buy a home, in addition to your mortgage and homeowners insurance, you will have to pay property tax based on the value of your property (real estate). City or county governments usually collect property taxes, but some areas also levy taxes by school district or business district. Many places don’t collect property taxes based on the entire value of your home, either. For example, you may live in an area that determines your property tax bill based on just 40% of the fair market value of your home.

Learn more about how property taxes work.

Personal property tax

Tangible personal property tax applies to tangible (physical) and movable items that an individual owns. State and local governments commonly levy taxes on certain kinds of personal property, like cars, boats, or structural additions to a mobile home. Businesses and self-employed workers may also have to pay tax on pieces of tangible property that are used by the business to earn income, like machinery and even furniture.

Taxes on goods and services

When you purchase certain goods or services, you may have to pay a consumption tax. Consumption taxes are often indirect taxes because even though the government is collecting from a retailer, the person who buys the good is the one who ultimately pays the tax. (A direct tax applies not to goods or transactions but to someone’s income, profit, or assets. Federal income tax and property taxes are direct taxes.)

Below are four common types of consumption taxes:

  • Sales taxes

  • Value-added taxes (VATs)

  • Excise taxes

  • Tariffs

Sales tax

Sales tax applies to goods or services you buy, and you pay them at the point of sale. There is no sales tax at the federal level, but states, counties, and cities may all have their own taxes. City and local sales tax applies in addition to state level sales tax.

Sales tax rates vary by location and by the type of sale. For example, a state may exempt clothing purchases from sales tax, but then collect a 2% tax on groceries and a 4% tax on all other goods.

Sales tax is also a type of ad valorem tax since the amount you pay depends directly on the value of what you’re buying.

Value-added tax

A value-added tax (VAT) applies to goods you purchase. It’s similar to a sales tax but different because a VAT isn’t just applied to the final sale price of a product. It applies at each stage of the production process, based on the value that has been added to the product. Since tax is applied throughout production, the price you see in a store already includes the VAT. This also differs from sales tax, which you pay in addition to a retailer’s price.

The U.S. does not have a VAT but it is common in other countries and especially in Europe. Like sales tax, this is also an ad valorem tax.

Excise tax

An excise tax applies to particular goods, services, and activities. Excise taxes are usually more specific in scope than a general sales tax, and they may be paid by retailers, consumers, or manufacturers. Excise taxes are a very popular way for federal and state governments to raise revenue. According to the Urban-Brookings Tax Policy Center, federal excise tax revenue in 2017 was nearly $100 billion. [80] Individual states may also have excise taxes.

Excise taxes are usually included in the price you see for a product instead of added at the point of sale like a sales tax. Some excise taxes are ad valorem: When you buy an airline ticket, there is a 7.5% excise tax included in the ticket price. Other excise taxes are the same no matter the value of the product. For example, the federal government levies an excise tax of 18.4 cents per gallon of regular gasoline. Whether a specific company was planning to sell you gasoline for $2 or $3 per gallon, the excise tax is still 18.4 cents per gallon. [81]

Common types of excise taxes you’ll see at either the federal or state level are on alcohol, tobacco, fuel, airfare, and telecommunications services. While a bit outdated, you may also see the term “sin tax” to refer to excise taxes on products or activities that are considered harmful to individuals or to society as a whole. The excise taxes on alcohol and tobacco are considered sin taxes, as are those on sugary drinks, gambling, and indoor tanning.

Tariffs

A tariff is a tax on goods that cross national borders. The country importing the good collects the tariff. In many cases, tariffs are a way for a government to bolster local businesses or to level the playing field with foreign competition. For a real-life example, here’s a look at tariffs the Trump administration imposed on Chinese goods.

Surtaxes

A surtax doesn’t fit into any single category because it’s just a tax on something that is already taxed. Surtaxes, sometimes called surcharges, usually apply only to individuals who are above a certain income or earning threshold. As an example, all taxpayers pay Medicare tax but single filers who earn more than $200,000 also have to pay a surtax of 0.9% (the Additional Medicare Tax) on all their wages that exceed $200,000. Some advocates of a wealth tax have also proposed it as a surtax on income above a certain income level.

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